Sunday, June 3, 2012

Choosing a Retirement Income Strategy: A New Evaluation Framework

Today's blog post introduces another new research article, which follows from the article I introduced yesterday. This article provides my initial attempts to build an evaluation framework to compare and analyze any sort of retirement income strategy, including fixed and variable systematic withdrawals, fixed annuities, GLWBs, and building a floor with partial annuitization. This article is, "Choosing a Retirement Income Strategy: A New Evaluation Framework." After clicking on that link you do need to follow through and click two more links and then you will have the PDF of the article.

This article presents the initial stages of a new evaluation framework for choosing among retirement income strategies. The investigation includes eight retirement income strategies: constant inflation-adjusted withdrawal amounts, a constant withdrawal percentage of remaining assets, a withdrawal percentage based on remaining life expectancy, a more aggressive hybrid withdrawal percentage, inflation-adjusted and fixed single premium immediate annuities, a variable annuity with a guaranteed living withdrawal benefit rider, and a strategy which annuitizes the flooring level to meet basic needs and uses the hybrid withdrawal percentage for remaining assets. 
These eight strategies will be analyzed with six retirement outcome measures over a 30-year retirement period: the average amount whereby spending falls below the minimally acceptable level, the average spending amount, the remaining bequest at the end of the retirement period, the minimum spending amount for any year in the retirement period, a measure of whether spending increases or decreases over time defined as spending in the first year divided by spending in the 30th year, and the value of total spending after accounting for diminishing returns from increased spending for a client with somewhat inflexible spending needs. 
Do note that there is no mention of failure rates, as failure rates do not have much meaning here. What matters is how far income may fall as financial wealth is depleted.
The model is applied to three client scenarios representing a cross-section of Retirement Income Industry Association’s client segmentation matrix. These scenarios include a severely underfunded couple who would need a 15% withdrawal rate to meet their desired expenses, a constrained couple who would need a 6% withdrawal rate to meet their desired expenses, and an overfunded couple who would need a 3% withdrawal rate to meet their desired expenses.
It is built using Monte Carlo simulations which reflect current market conditions, so that systematic withdrawals and guaranteed products share compatible underlying assumptions.
It is hard to summarize the results, because it depends on the unique financial circumstances of retirees as well as their uniquely personal preferences about the tradeoffs between downside protection, upside spending power, and leaving a bequest.  Please have a look!